Hope for China to Drive Global Economy Is Just an Illusion

A man rests in front of screens showing stock prices at a securities company in Beijing on Jan. 21, 2019. (GREG BAKER/AFP/Getty Images)

News Analysis

Many attribute China’s 2018 economic slowdown to the U.S.–China trade war.

With a prospect of continued softness in 2019, many countries impatiently wait for the end of the trade war. They look toward China’s return to economic growth, hoping that China will continue to be the engine of the global economy, the biggest buyer of resources, and the biggest consumer of products made by developed countries. Even in Germany, the “engine of the European economy,” its business community also shares such hopes. They do not realize it’s purely wishful thinking—in fact, China’s economy started to decline as early as 2015, and the current trade war has just accelerated the process.

China’s Overseas Shopping Spree Stopped

In the past 15 or 16 years, Chinese buyers have been a key driver of some countries’ economic growth. There are two types of buyers. One is investment, including major mergers and acquisitions by China’s state-owned enterprises and overseas investments by the private sector. The other is international tourism by Chinese consumers, accompanied by the purchase of luxury products.

China’s overseas investments seem strong. According to the 2017 Statistical Bulletin of China’s Outward Foreign Direct Investment, issued by China’s Ministry of Commerce, China’s total foreign direct investment was $158.29 billion, only behind the United States and Japan. Its foreign direct investment was the world’s second highest at $1.81 trillion. From January to September 2018, China’s overseas mergers and acquisitions were $1.07 trillion, 11.2 percent higher than the previous year, according to Thomson One.

But in the meantime, the privately owned businesses that have been buying assets overseas, such as HNA Group, Dalian Wanda Group, Anbang Insurance, and Fosun International, have been selling their previous purchases with deep discounts and moving the money back to China. The reason behind this is pressure from the Chinese Communist Party government.

According to the Financial Times, China’s HNA made more than $40 billion worth of overseas acquisitions between 2015 and 2017. Now HNA is selling its properties bit by bit at low prices from stocks, real estate, to even office buildings. On Dec. 26, 2018, during the China Brand Forum, Chen Feng, the chairman of HNA, said in an interview that it had sold over 300 billion yuan ($44 billion) of assets in 2018 alone, setting a new world record.

These companies all have more than a 70-percent debt ratio. Their funds for the M&A activity came from Chinese bank loans or financial products they issued. Their shopping spree caused China’s foreign exchange reserves to plummet. At the end of 2016, China’s foreign exchange reserves dropped below $3 trillion. Chinese Premier Li Keqiang had to face the embarrassing reality, “Right under my nose, I watched hundreds and hundreds of billions of capital flowing away.”

Against this backdrop, the China Banking Regulatory Commission ordered a thorough overseas credit audit and risk analysis on businesses including Wanda, Anbang, HNA, Fosun and Zhejiang Rossoneri. Focusing on M&A and coercive lending, an internal battle to protect foreign exchange reserves began.

As China’s private sector giants move capital back to China and Chinese buyers decline in number, housing prices dropped in places like New York City and Australia. For many years, soaring Chinese capital had boosted housing price globally. The trend has reversed since 2018 when the Chinese government tightened control over capital outflows.

According to Real Capital Analytics statistics, Chinese companies and organizational investors sold $233 million worth of real estate in Europe including hotels, office buildings, and other commercial properties, and purchased only $58 million of real estate in Europe. In the United States, Chinese investors sold more than $1 billion against purchases of only $231 million.

In Australia, the housing market is cooling down due to the declining number of Chinese buyers. Analysts universally predict that the real estate market will continue to decline in 2019.

China No Longer a Dream Market for Foreign Investors

In his article “American Entrepreneurs Who Flocked to China Are Heading Home, Disillusioned,” Wall Street Journal reporter James T. Areddy said that foreign entrepreneurs find it much tougher to do business in China due to “soaring costs, creeping taxation, tightening political control and capricious regulation,” and that “their best days were in the past.”

The problems with the Chinese investment environment discussed in the article have actually existed for a long time. In addition to rising land and salary cost, foreign investors are also burdened with regulation costs (losses due to the lack of transparency in policy and law) and external costs (e.g. costs incurred to protect intellectual property or business credibility) which are tightly connected to government policies.

The article specifically called out the external cost for intellectual property-related challenges, saying U.S. businesses had spent a lot of money and effort on intellectual lawsuits, but was not even close to stopping infringement by Chinese companies. German and French companies also had Chinese partners steal their technology and start their own businesses. Intellectual property infringement remains a major issue today, and has become a trigger of the US–China trade war.

The China market has attracted capital from around the world since the 1990s, especially from Japan, the United States, and Europe. Not all foreign investments made a profit, or even survived. Their first wave of capital retreat happened from 1999 to 2003 (mainly industrial capital), followed by the second wave from 2008 to 2013 that involved both manufacture and financing. The current wave started at the end of 2015.

I have been tracking foreign investments in China, and found that all three waves of capital retreats happened for similar reasons, namely cost (land and labor costs), taxation burdens, and the regulatory environment. Billionaire Li Ka-shing is among the early birds in the retreat. Though he had made quite some money in China, he was ready to exit at the peak of his China business. His Hong Kong-based CK Hutchinson conglomerate began to sell assets as early as 2008 and, at the same time, established a capital system in Europe. By the end of 2017, Li had cashed out 150 billion yuan ($22 billion) over the decade, and European business accounted for nearly 40 percent of his revenue while the greater China share dropped to about 30 percent. Taiwanese tycoon Terry Gou built his fortune in mainland China, but he began to increase investment in other countries in 2015.

The above facts show that China has long lost its charm as a “dream market.” The trade war only reinforced foreign investors’ decision to leave China, and made the situation more difficult for China.

Chinese Consumer Demand Crushed by Housing Debts

Lately, Apple’s poor performance in China has received a lot of attention. But the loss was just moved up a couple of years, because the decline of Chinese consumer buying power has already begun. Many external analysts ignored the fact that the buying power decline was not a result of the trade war, but the consequence of China’s economic structure and income distribution.

1. Income disparity is worsening. According to official statistics, China’s Gini coefficient (income inequality measurement) has grown for three consecutive years since 2015. In 2017, the index reached 0.467, higher than the United Nation’s threshold for a dangerous level of 0.4. Economic theories hold that the marginal consumption propensity of high-income consumers is lower than that of mid/low-income consumers. As a result, a country’s domestic consumption grows only when mid/low-income consumers spend more. Chinese consumers contributed to one-third of the world’s luxury goods sales in 2016, according to McKinsey’s “China Luxury Report 2017.” A large part of luxury goods purchases happened overseas, so it has very limited impact on China’s domestic market.
2. Chinese consumers’ leverage ratio remains high, limiting the growth potential or consumer consumption. The Chinese Academy of Social Sciences estimated that China’s consumer leverage ratio (consumers’ debts to GDP) soared from 28 percent in 2011 to 49 percent in 2017. The per capita debt is 170,000 yuan (approximately $25,000) according to official data. In January 2018, some predicted the per capita ratio will be over 60 percent, and personal housing loans will be the key driver of growing debts. All other industries will feel the pressure, simply because the heavy mortgage burdens will inevitably impact all other consumptions as China’s homeowners struggle to pay their mortgages.

Adjusting Economic Structure is Better Than Fantasizing About China’s Rescue

No matter how much foreign analysts wish to see China recover and continue to drive global economic growth, the truth is that China’s growth has come to an end. As heavy-handed as the Chinese government is in controlling the economy, it has no other strategy than to print more money and increase government spending.

In January 2019, China’s central bank announced it would cut the bank reserve requirements by 1 percentage point to spur bank loans. The move will inject 150 million yuan ($22 million) to the market. This was the fifth time the central bank lowered bank reserve requirements in less than a year. In the meantime, China’s macroeconomic management agency—the National Development and Reform Commission (NDRC)—approved over 1.2 trillion yuan of infrastructure projects such as metro light rails, showing infrastructure again became Beijing’s key approach to “stabilize the economy.”

For many years, China’s capital moved from the real economy to economic bubbles via real estate and the stock market. A recent International Monetary Fund report said such credit stimulus has brought China to a point of diminishing returns. Since part of the new debts will be used to repay previous debts, to realize the same growth as before, the country will need three times as much debt. Therefore, China’s biggest challenge is to prevent loans from turning into bubbles.

The world is witnessing all sorts of frictions and turmoil that accompany the reversal of globalization. President Donald Trump did not sabotage the existing global trade system. Instead, he adjusted the structure into two separate systems: a system of free trade between the United States and its traditional trade partners, and another system outside of the free trade system that includes China.

So far, neither system has been fully shaped, but it is certain that China won’t be able to serve as the engine for the global economy. Instead of looking to China for rescue, I think western countries should adjust their own economic structure to fit into a world without China as the buyer and investor.